Sales Compensation Plan: A Step-By-Step Guide with Examples
Just when you think you’re about to meet your sales target for the quarter, you get hit with the news that your star rep is throwing in the towel and moving on to a higher-paying role.
You’re already short-staffed, and now you’ll have to deal with lost momentum, team morale, and your quarterly bonus—bummer!
The average tenure of a sales rep is 18 to 20 months, making this scenario all too common. Yet many sales leaders don’t realize how easy it is to prevent turnover by designing an attractive compensation plan.
This comprehensive guide will guide you through every step of creating a sales compensation plan that motivates salespeople to hit their targets and allows you to attract and retain top performers.
What’s a Sales Compensation Plan?
Your sales compensation plan determines how to reward salespeople based on how much revenue they generate, how long it takes to close deals, and how risky the deals are.
They are the backbone of any successful sales strategy and the key to retaining top sales talent.
Creating compensation plans for enterprise B2B companies usually takes a committee of executives, human resources, sales, and finance managers. Their goal is to ensure that the plan aligns with company objectives while staying competitive within industry standards.
Crafting win-win strategies that benefit both the business and the sales rep can be a complex and challenging exercise that requires a delicate mix of business analytics and creative thinking.
What Are The Types of Sales Compensation Plans?
One of the most common compensation structures is “variable compensation,” which is pay given to employees based on their results. It is usually offered on top of a fixed salary and comes in various forms. But generally speaking, their structure falls into one of these four categories.
In this type of sales compensation plan, employees earn payment based on their ability to meet sales quotas—revenue targets set by sales managers — within specific deadlines.
In other words, you’ll reward salespeople with additional compensation if they meet or exceed a sales goal.
For example, an employee with a sales quota of $500,000 can get a 5% bonus or commission on the total amount of their sales if they reach or exceed their goal. Meaning they would make an additional $25,000 when they meet their target.
Quota-based compensation plans are often favored when the company is after higher-value contracts.
Sales reps on a time-based plan are racing against the clock. This incentive compensation plan rewards employees with an additional bonus if they reach their target within a specific timeframe.
For example, an employee can receive an additional $500 for completing ten sales before the end of the first quarter.
This plan emphasizes sales volume over sales value, making it an excellent strategy for selling low-contract-value goods or services.
Versatile and effective hybrid plans combine quota, time, and other incentives into an all-encompassing plan designed to optimize urgency and contract value.
For example, in a hybrid plan, a salesperson might receive a $50,000 base salary and a 5% commission on the first month of sales; then earn a 1% commission afterward.
Companies implement hybrid plans when there’s a need to strike a balance between sales performance and service. Implementing hybrid plans is also a great way to drive urgency for specific promotions like limited-time offers.
Individual incentives are rewards or bonuses given to employees who meet or exceed their sales targets within their regular compensation plan. Simply put, the more sales a rep makes, the more they earn.
These incentives can be financial, such as paying commissions or retention bonuses, or non-financial, such as recognition or vacation time. Individual incentives are great for motivating employees to achieve their set targets and ultimately generate more revenue for the company.
These incentives benefit both the employee and the company by motivating the sales team to achieve more. This leads to increased job satisfaction and an increase in revenue. Incentives also show appreciation which helps retain top performers.
How Sales Compensation Plans Work
To be effective, your organization’s sales compensation plan must balance encouraging high performance and prioritizing customer satisfaction. Your business will suffer if the scales are out of balance.
Poorly constructed and executed compensation plans can cost your organization key sales representatives and valuable sales targets.
If a sales compensation plan focuses only on high performance over customer satisfaction, sales representatives may prioritize quick sales without building long-term relationships or understanding customer needs.
This approach can lead to negative customer experiences, decreased customer loyalty, and potential damage to the company’s reputation.
To achieve a fair balance and build the right compensation plan for your sales team, tailor your incentives to the company’s and your reps’ specific needs.
For example, if your organization wants to increase market share, tailor the plan to incentivize sales by acquiring new customers rather than expanding the existing customer base. You’d achieve this by offering first-time customers a higher commission than repeat sales.
Organizations typically use the following compensation incentives to influence sales rep behavior:
- Sock options
- Other forms of compensation or equity
Each stage of business growth, whether startups or scale-ups, will require a unique approach since each has its own challenges.
For example, a start-up and a scale-up will have very different business goals, which require different compensation plans for each.
Startups might require a more aggressive approach focused on quick user acquisition and minimum viable product (MVP) validation, while a scale-up compensation plan must focus more on sustainable growth.
How to Create an Effective Sales Compensation Plan
A well-designed plan can unlock your team’s full potential, increase productivity, and drive sales. Conversely, a poorly-designed plan can lead to unmotivated employees and negatively impact your bottom line.
While there’s no one-size-fits-all compensation plan, these steps will help you create the best sales compensation plan.
- Form a sales compensation planning committee
Developing a successful sales compensation plan for your sales team begins with creating a compensation planning committee.
Your compensation planning committee will collectively represent the diverse expertise your organization needs to craft a fair and effective compensation philosophy.
These stakeholders might include leaders from:
- Human resources
- Business intelligence
- Sales operations
- External consultants
- Board members
By gathering stakeholders with an interest or ownership in the compensation process, committees can:
- Break down communication walls
- Improve operational efficiency
- Achieve quick approvals
- Increase the bottom line by driving business goals effectively
- Bring greater returns
- Reduce costs by reducing friction in sales operations
When developing a compensation plan, the committee is a day-one, but not a one-day priority. Meeting frequently to fine-tune the plan and review its progress should be a crucial focus for organizations of all sizes.
- Collect and analyze historical performance data
Because compensation is a living-breathing dynamic strategy, you’ll continually fine-tune your plan. This is not a once-a-year task but an organic, liquid exercise that needs constant monitoring and updating.
While core sales incentive programs rarely change throughout the year, businesses typically make adjustments in the form of:
- Product launches
- New components
- Personnel changes
To maximize the impact of a compensation plan, your organization’s compensation committee should meet regularly and analyze sales performance management (SPM) data. This will enable the committee to monitor the plan’s effectiveness continuously.
To start, you’ll need to understand your organization’s data sources and the types of data you’ll need to measure your plan’s success.
While CRMs do a good job of centralizing data, they tend to tell only some of the story. That’s because CRMs are only as good as the data they’re fed—often incomplete or inaccurate.
Sales reps are less eager to spend hours inputting data into a CRM or checking for accuracy when they could (and should) be making sales.
By implementing a reliable single source of truth, your committee will make informed decisions and steer the compensation plan in the right direction.
The solution for most companies is to opt for a purpose-built performance platform that offers the flexibility and complexity most CRMs lack.
This platform will serve as a reliable and single source of truth for sales compensation data that focuses on fact-based sales performance management. This single source of truth is an ideal tool to optimize sales planning and leverage reliable insights and data.
- Map out strategic revenue goals for the new year
Creating a sales compensation plan requires understanding your business’s objectives for the upcoming year and aligning them with incentives that motivate your team.
For example, let’s assume your company’s revenue goals for the year include increasing the number of paying customers while reducing customer churn.
Now that you have those goals mapped out, your sales compensation committee could incentivize sales reps by offering bonuses on commissions that align with them.
For example, paying a significant one-time bonus for each new customer, they bring on or offering a bonus based on customer retention to reduce churn rates.
Once you’ve mapped out your strategic goals, align them with specific strategies influencing the right behaviors. Setting clear objectives and key results can help align teams toward a common purpose and track progress toward achieving goals.
- Communicate your new sales compensation plan
Without effective communication, even the best-designed sales compensation plans won’t succeed. After all, ensuring a smooth transition and a successful roll-out requires that reps understand how to engage with your strategy and profit from it.
Management teams can use a change management framework such as ACE (Awareness, Commitment, Engagement) to plan effectively. The ACE model can help nurture teams during the plan’s rollout and serves as a way for organizations to look ahead and think through every step of the launch.
Sales Compensation Planning Tips
Whether you’re a compensation planning expert or this is your first rodeo, these tips can help you craft a win-win sales compensation plan for your organization.
Tip #1 – Focus on engagement
Sales compensation plans often fail when the sales rep team becomes disengaged.
If reps fail to engage with the plan during the first weeks of the rollout, they’ll probably struggle to hit their targets or quit altogether.
To keep reps engaged, prioritize training them before the rollout, and don’t overcomplicate your plan. Complicated compensation plans create confusion and foster disengagement. But if your reps can understand how to profit from it, they’ll engage with it meaningfully.
To avoid overcomplicating your plan, your organization will need to work on reducing the plan dimensions by having the following:
- Simple commission structures
- Fewer and less complex exceptions
- Simplified math to determine the payout amount
- Well-defined territories
- Clear and fewer performance metrics
Tip #2 – Easy Does It
If it takes more than a few hours and mugs of coffee for your team to understand your sales compensation plan, you’re probably doing it wrong.
The success of your sales commission plan depends on reps understanding which behaviors benefit them. So strike a balance between making the plan detailed enough to incentivize behaviors that benefit the company and easy enough for reps to understand it.
Sticking to two or three critical activities like revenue generation and customer retention will keep the compensation plan simple and help drive the behaviors needed to reach the company’s goals.
Other vital activities your plan can focus on include
- Revenue generation
- New customer acquisition
- Product or service upselling
- Upsell incentives
- Customer retention
- Retention bonus
- Sales team collaboration
- Sales training and skill development
Tip #3 – Determine On-Target Earnings
On-target earnings (OTE) is a sales rep’s projected annual pay if they achieve their goals. OTE generally includes a base salary and a realistic projection of commissions or bonuses from deals that are closed on time. However, a rep could earn less if they don’t meet their goals, or if the comp plan allows, they could exceed their targets and earn more.
Before deciding which type of compensation plan is best for your organization, it’s essential to determine OTE.
Accurately determining OTE can help your organization set realistic goals by aligning sales targets with compensation structures. This ensures targets are challenging yet attainable.
A well-defined and competitive OTE also serves as a magnet for talent, helping your organization attract and retain top performers. That’s because fair and competitive OTE structures create a sense of stability and financial security. This prevents talented salespeople from looking elsewhere.
Tip #4 – Don’t Cap Compensation
Unless your organization’s sales goals are to limit the speed of its revenue engines, you should not cap sales compensation.
Some companies might believe penalizing a small number of high-performing reps is a small price worth paying to mitigate organizational risk. This couldn’t be further from the truth!
Capping compensation creates more problems than it solves and only does two things: demotivates reps to sell and scares away your top performers.
A compensation cap typically affects your top 20% performers—the cream of the crop. By doing so, you’re cutting the legs of a revenue-generating force that tends to account for 80% of a company’s revenue. This is the fastest way to stunt your organization’s growth.
Tip #5 – Align Roles and Incentives
Align your incentives with specific roles and goals. For example, if you want to fix your customer churn, you can adjust the comp plan for product managers by tying their bonuses directly to net revenue retention (NRR). This can improve the product experience and enhance customer retention.
It’s easy to get lost in commission rates or bonus structures and not think about the bigger picture and the impact that roles and responsibilities on the sales team have.
It’s best practice to align roles to incentives first and mechanics second. Then, make sure you decide on things like base salary, commissions, bonus structures, and performance metrics.
Sales Compensation Plan Examples
Now that you know how to craft a balanced and effective compensation plan, it’s time to see examples of different compensation packages and how each might fit within your own organization.
These are some of the most common types of sales compensation plans:
Base Salary + Commission
A base salary plus commission structure is the most common type of sales compensation plan. The pay structure offers employees the security of a salary while also offering motivation through commission.
For example, a sales rep can earn a $50,000-a-year base salary and a 10% commission on each sale.
It’s normal to find a 60 to 40 split between salary and commissions in this model. Meaning reps earn 60% fixed income and 40% variable. However, that ratio gets closer to 70:30 or 75:25 when you expect your sales rep to educate a prospect about a complex or technical product.
The longer a sale takes, the more complex the process, and the more influence a salesperson has on the closing, the higher the commission percentage should be.
Salespeople rarely receive salary-only compensation. While employees might prefer salary predictability, this compensation model does little to motivate reps to hit targets.
If sales reps reach their quota, they may relax rather than push forward because there is no added incentive to go the extra mile.
A salary-only compensation structure also does little to attract and retain top-performing salespeople. They might leave your organization or not join if they could make more money through commissions elsewhere.
Salary + Bonuses
Consider a base salary plus bonus compensation plan if your sales reps consistently achieve their pre-set goals. This compensation structure pays a bonus if sales reps hit the pre-determined sales target.
Compensating employees this way offers organizations predictability with the added benefit of motivating reps to hit their sales quotas.
For example, your organization could pay sales reps a $55,000 base salary with a bonus of $10,000 for selling X amount of products or services throughout the year.
Let’s assume your organization expects five reps to meet their quota. If so, you can set aside everyone’s salary plus an additional $50,000 in your annual budget for their commissions, leaving little room for surprises.
Companies with a commission-only structure pay their employees based solely on sales performance.
For example, a sales rep might make a 3% commission per subscription. But if the sales rep does not sell any subscriptions during the pay period, they will take home zero pay. If they do, they might take home pay only after the customer signs the contract and pays a deposit.
Businesses offer commission-based plans to employees as a way to minimize risk. However, while commission-only plans can be high-reward for salespeople, they often come with heavy pressure and discomfort.
Gross Margin Commission Plan
A compensation plan that improves net income can employ a gross margin model to incentivize profits.
Unlike other compensation methods, gross margin commission focuses on the profitability of a sale rather than the revenue generated; that’s because it pays pay reps based on profit. This practice encourages sales reps to prioritize more profitable deals, benefiting both the rep and the company.
For example, if a sales rep closes a deal worth $10,000 for a new product and costs $6,000, the gross margin would be $4,000. Therefore, the total commission rate for this sale would be $400 (10% of $4,000).
Let’s say another sales rep closes a big deal worth $100,000 for the same product but offers the client a 20% discount. In this case, the product cost would be $80,000, resulting in a gross margin of $20,000. The commission rate would be $2,000 (10% of $20,000).
Startups commonly use equity models as incentives to attract talent and retain capital. Equity offers long-term employees part ownership in stocks, stock options, or other types of equity.
For example, an employee might have the option to take a salary of $50,000 with the option to own 5% of the company’s shares. That means if the company is valued at $1 million, the employee’s shares would be worth $50,000.
This type of compensation model can be attractive to employees because as the company grows and becomes more valuable, the value of their shares can increase. It also aligns the interests of employees with the company’s success, as employees have a direct stake in the company’s future.
Companies use profit-sharing compensation structures to distribute some of their profits to their employees. Eligible employees will share the excess profits if the company exceeds its financial goals.
For example, let’s say that a company sets a financial goal of making $1 million in annual profits. As part of their profit-sharing program, the company might decide that if they exceed their goal by more than 1%, the excess profits will be set aside for distribution to eligible employees.
The amount each employee receives will depend on salary, seniority, and performance. For instance, an employee who has been with the company for a longer period or has performed exceptionally well may receive a more significant percentage of profits.
Profit sharing can incentivize employees to work harder and be more productive, as their efforts directly impact the company’s financial success. It can also help to create a sense of loyalty and investment in the company’s future.
Territory Volume Plan
If your team wants to boost sales in an underperforming region, territory volume incentives are the way to go. Sales reps earn rewards based on the number of sales they generate in a specific territory.
For example, a sales rep earns a base salary of $60,000 and receives a 5% commission on their sales volume, with the potential for a Territory Volume Bonus of up to 5% if they achieve a sales volume increase of 20% in a designated region.
Not only are territory incentives a great way to even the scale in challenging regions, but they also serve to compare a salesperson’s performance in different territories.
Merit-based pay compensates employees based on their individual performance and contribution to a company’s success. Unlike other pay structures like incentive-based or straight salary, merit pay focuses on the quality of work rather than just quantity.
Merit pay can greatly benefit sales reps, especially when sales performance is directly tied to a company’s profits.
For example, a company that wants to increase its profits from $5 million to $8 million annually may incentivize its sales team with merit pay. The company may award a bonus or increased pay if a sales representative achieves or exceeds their sales targets.
In industries where productivity and efficiency are essential, merit pay can lead to significant cost savings for the company through decreased turnover rates and increased employee engagement.
The Bottom Line on Choosing a Sales Compensation Plan
Your sales compensation plan is directly linked to organizational performance, making it a complicated yet crucial undertaking. But designing and implementing an effective plan with the right tools and expertise is possible.
With tools like Forma.ai, your organization can design plans, territories, and quotas with ease and peace of mind. Forecasting the impact of your designs at every level has never been this easy and accurate.
Ready to create a sales compensation plan that retains and attracts the best reps and lets them focus on selling?